Your monthly market outlook from atomos.
Prime Minister Rishi Sunak wants to overhaul the UK’s net zero strategy to protect the economy. In a recent speech, he argued the costs associated with reaching net zero carbon emissions would place an unacceptable burden on UK households which are already struggling with the cost of living crisis.
He pushed back a ban on new petrol and diesel cars from 2030 to 2035 and announced changes or delays to several other green policies including heat pumps and home insulation. Instead, he plans to bring forward reforms to grid infrastructure to bring renewable energy into more households. Sunak said with these changes the UK will still be on track to reach net zero by 2050.
Net zero means cutting greenhouse gas emissions as close to zero as possible in order to prevent a global temperature rise of more than 1.5 degrees. The aim is to avert the worst impacts of climate change. To do this, the world needs to cut its carbon emissions by 45% by 2030 and reach net zero by 2050.*
Globally, much more investment is needed to meet the Paris Agreement target of keeping global warming below 1.5 degrees. The chart below shows the level of finance which will be required from governments and corporations, and how far it falls short on its current trajectory.
The risks of a disorderly climate transition
As well as finding the money required, policymakers across the world are concerned about getting the timing and pace of their net zero strategy right. Markets might expect that policymakers, when faced with financial instability driven by a chaotic and accelerated transition, would choose to miss climate targets rather than cause elevated risks. Sunak’s policy announcement looks a bit like this. If this is the case, the key risks will be physical risks from faster climate change as climate targets are missed and emissions climb, rather than the costs of a disorganised transition.
As well as the timing of the climate transition, another of the biggest risks to the financial system would be if a mismatch emerged between supply and demand for low- or high-carbon products and services. If companies and investors fail to recognise a pending collapse in demand and then face a shrinking market for their products, this could cause write-offs and significant losses of value. In the worst-case scenario, these losses are recognised and priced in suddenly, causing equity markets to fall sharply. Investors in these markets then experience losses that constrain investment and growth in the economy. This could ultimately lead to stagnation, recession, and financial instability.
Although this gloomy narrative remains plausible and concerning, we note that the share of the developed world equity index represented by the sectors most at risk to a climate transition – energy, utilities, metals and mining, steel, chemicals, high carbon transport and so on – has fallen significantly in the last five years. This means that some of the risk has already been priced into equity markets.
How investors can help build a low-carbon economy
It is clear that different sectors and countries will follow their own timescales and paths towards climate transition. For instance, we have seen significant transitions around coal-fired power in the US and Europe, while a move to phase out thermal coal in China started, sputtered, reversed, and now remains uncertain. This brings many different opportunities for investors to capture returns, but also comes with risks as there will be winners and losers, leaders and laggards in the transition.
Asset managers and investors themselves also have a crucial role to play in achieving net zero.
WTW, the global asset manager which powers atomos investment portfolios, has made its own pledge to reach net zero by 2050 and to halve emissions by 2030 on its delegated assets including the atomos Multi-Asset Funds.
A recent paper from WTW’s Thinking Ahead Institute said the only way the world will manage the climate transition is if investors stop investing high emitting assets such as thermal coal and instead invest in substitutes such as renewable energy and negative emissions technologies. This will require “a fundamental shift in mindset and approach”, it warned.
However, the report also noted that one-third of global assets under management are now in ESG funds (funds which take environmental, social and governance considerations into account when investing). It suggested that ESG investing could help shift the dial.
Central banks hold firm on rates
In other news this month, central bank policy decisions dominated the headlines. The US Federal Reserve, the Bank of Japan and the Bank of England all held interest rates at their latest meeting but there was a hawkish message coming from the US in particular, meaning policymakers are hinting at tightening monetary policy rather than loosening it. Markets responded quite negatively to this and a lower economic growth outlook more broadly. The Bank of England’s Monetary Policy Committee voted to hold the base rate at 5.25% but it was a close-run thing at 5-4. There was a unanimous agreement to sell £100bn of government bonds over the next year in a further tightening of monetary policy. We see the move to pause rate increases for the first time since December as a sign that economic growth is slowing. This is backed up by the latest Purchasing Managers’ Index (PMI) reading which showed a 32-month low, pointing to a contraction in business activities.
Inflation is trending down - UK core inflation fell from 6.9% to 6.2% between July and August – but is still far above the BoE’s target rate of 2% so we think it will maintain a restrictive stance to try to bring inflation down further. BoE Governor Andrew Bailey has stressed that borrowing costs could rise again if there is evidence of more persistent inflation pressure.
Property sector underperforms
As interest rates have climbed in developed markets over the last couple of years, this has created problems for the property sector, especially residential property. In the UK, high mortgage rates have dampened buying and selling activity, with new mortgage approvals for house purchases now below pre-pandemic levels, although strong wage growth has cushioned some of the impact. World real estate has significantly underperformed global equities over the last year. In client portfolios we are investing in other areas of real estate such as offices, industrial properties and data centres, and in real estate outside the UK, alongside our investments in global stocks. We don’t have any pure UK housing exposure in the portfolios. In this way we aim to protect the value of investments from being overly reliant on individual sectors such as the UK property sector.
Any kind of large policy shift can have implications for financial markets and, by extension, investment portfolios. We follow current events and government statements closely, but we don’t make knee-jerk changes to investments on the back of policy changes. We believe the best strategy for long-term investing success is diversification, active management, and careful risk controls.
The information and opinion contained in this Monthly Commentary should not be treated as a forecast, research or advice to buy or sell any particular investment or to adopt any investment strategy. Any views expressed are based on information received from a variety of sources which we believe to be reliable, but are not guaranteed as to accuracy or completeness by atomos. Any expressions of opinion are subject to change without notice. Past performance is not a reliable indicator of future results. Investing involves risk and the value of investments, and the income from them, may fall as well as rise and is not guaranteed. Investors may not get back the original amount invested.